Our ratings on Japan-based home mortgage lender Asahi Kasei Mortgage Corp. (A/Negative/--) reflect its close operating and financial relationships with ultimate parent Asahi Kasei Corp., direct parent Asahi Kasei Homes Corp., and other Asahi Kasei group companies. The ratings also reflect its capacity, from the point of view of our credit analysis, as the captive finance division of the group; and its excellent asset quality. Constraining the ratings are susceptibility to the entire group’s credit quality and business strategies. Also constraining the ratings is the possibility that Asahi Kasei Corp. may need a substantial amount of time to improve its financial position following weak earnings in its core chemicals business.

Asahi Kasei Homes’ “Hebel Haus” brand--a built-to-order system aimed exclusively at high-income homebuyers--is highly competitive, mainly in large metropolitan areas, and orders have continued to grow. Standard & Poor’s expects Asahi Kasei Homes’ strong product competitiveness, sales capabilities, and solid customers to underpin Asahi Kasei Mortgage’s business. In general, the housing business is susceptible to changes in government financial support for homebuyers. However, streamlined sales and marketing continuously enhance Asahi Kasei Mortgage’s profitability, somewhat reducing the effect of government policy.

New orders in Asahi Kasei Mortgage’s lending business dropped sharply toward the end of fiscal 2011 (ended March 31, 2012), mainly owing to the many customers who opted to use “Flat 35” loans. However, following the Sept. 30, 2011, cessation of applications for the very low, preferential rates provided temporarily under the “Flat 35” loan program, the company’s own housing loans with preferential lending rates have attracted a gradual flow of new customers. The company’s strict risk management standards lead us to believe the new loans are unlikely to lower Asahi Kasei Mortgage’s asset quality.

In Standard & Poor’s view, Asahi Kasei Mortgage’s lending operation has excellent asset quality. The company securitizes its mortgage loan claims but the company continues to hold subordinated beneficial interests. As such, we believe Asahi Kasei Mortgage still assumes the credit risk on such loans. Nevertheless, the company’s asset quality is extremely sound, in our view: it has had no charge-offs, or even arrears of greater than a month, since it began operations in 2004. Standard & Poor’s is also of the opinion that the overall lower credit risk of the residential mortgage loans has significantly benefited the company’s sound asset quality, which is further supported by the group’s focus on high-income homebuyers, Asahi Kasei Mortgage’s conservative underwriting policy, and its record of promptly resolving short-term arrears. We, based on the aforementioned factors, expect credit risk related to Asahi Kasei Mortgage’s residential mortgage loans to remain within a manageable range, although the company may incur credit costs in the future as the loans age.

The Asahi Kasei group engages in a wide range of businesses, including petrochemicals, electronic components and materials, housing, construction materials, pharmaceuticals, and medical services. Sales of products with high market shares and which are high-value-added account for a large proportion of the group’s overall earnings. As a result, Standard & Poor’s believes the group’s earnings are relatively stable. The group is likely to make its business more stable by diversifying operations and strengthening its nonchemicals businesses to underpin earnings. For example, the group is strengthening the earnings of its health care business through its acquisition of U.S. health care equipment maker ZOLL Medical Corp., which it completed in April 2012. In addition, it has launched a new drug with potential to support earnings growth. The group has also improved the profitability of its housing business in recent years.

Weak earnings in Asahi Kasei Corp.’s core chemicals business amid a fall in Asian markets makes profitability likely to take time to recover, in our view. Also, the debt-financed acquisition of ZOLL Medical has worsened Asahi Kasei Corp.’s financial position (after adjustments for captive finance operations). The ratio of its funds from operations (FFO, before adjustments for changes in working capital) to total debt on a consolidated basis was 58.5% as of March 31, 2012, but plummeted to 26.1% as of Sept. 30, 2012, following its acquisition of ZOLL Medical. Nevertheless, we expect the nonchemical businesses to help Asahi Kasei Corp.’s profits and cash flows recover gradually, lifting the ratio to the mid 30%-40% range by March 31, 2013.

Liquidity

We assess Asahi Kasei Mortgage’s liquidity as “adequate,” according to our criteria, reflecting the liquidity of both the company and Asahi Kasei Corp. Asahi Kasei Mortgage securitizes its loan claims to meet its long-term financing needs, and for short-term working capital it relies on Asahi Kasei Homes Corp. Despite limited sources, Asahi Kasei Mortgage has sufficient liquidity for its funding needs. In addition, Asahi Kasei Corp. also maintains adequate liquidity on a consolidated basis.

Outlook

The outlook is negative. We see at least a one-in-three likelihood that a recovery in earnings in Asahi Kasei Corp.’s chemicals business will require more time, which, in turn, would slow recovery of its financial position. We may consider lowering the ratings on Asahi Kasei Mortgage if we reduce our assessment of the group’s credit quality owing to a slow recovery in the profitability of the group’s chemicals business, which would further stall improvement in the group’s financial performance. We may lower the ratings if we see Asahi Kasei Corp.’s FFO to debt as unlikely to recover to 40% in the next 12 months. We may also downgrade Asahi Kasei Mortgage if its asset quality deteriorates considerably because of an increase in loans in arrears or if the company’s position as the group’s captive finance division changes. On the other hand, we may consider revising the outlook to stable if we see clear prospects for Asahi Kasei Corp. to swiftly improve its FFO to debt to over 45% on a sustained basis.